When I got rejected from my mortgage refinance in early 2015 I was pissed. I was in the third month of waiting before I got the bad news. I had locked in an outstanding 2.25% 5/1 Jumbo ARM rate that could have saved me $400 a month for the next five years. Having an 800+ Experian FICO score and a multiple six figure income was not good enough because a large portion of my income came from freelancing. Traditional banks require two years of freelance income history before ANY of it counts.
In 2012, another mortgage refinance almost got derailed. TransUnion, one of the major credit agencies, unbeknownst to me, had my FICO score down to 680 because a former tenant forgot to pay an $8 utility bill after moving out. PG&E, the utility company, didn’t bother to shoot me an e-mail, give me a ring, or send me a letter for the outstanding invoice. Instead, PG&E sent my name to a collections agency! Luckily, I got PG&E to write to my bank a “clear credit letter” and my refinance went through.
My 800+ Experian FICO score didn’t help me get a mortgage refinance, and my 680 TransUnion FICO score almost screwed me. Back then, it was clear to me that the FICO score was seriously flawed. Therefore, I was happy to hear SoFi, one of the leading online lenders who raised $1B in funding in 2015 from Softbank, decided to completely drop the FICO score from its loan qualification application for 2016 and beyond.
FICO-FREE LOAN QUALIFICATION
Instead of using FICO scores, SoFi considers three criteria — employment history, track record of meeting financial obligations and monthly cash flow minus expenses — to determine if an applicant is qualified for its loan products. These include student loan refinancing, mortgages and personal loans.
Dan Macklin, a co-founder of SoFi, writes about why they are dropping FICO.
“The FICO score calculation doesn’t consider things like your savings, your cash flow, your ability to pay non-credit bills like water and electric or your future earnings (for example, if you just landed a job with excellent pay). Plus there’s the fact that a growing number of millennials are forgoing credit cards entirely, which is reflected negatively in their credit scores – even though they may be perfectly able to pay off a loan. All of these factors can have a major impact on your creditworthiness, but your FICO score doesn’t take them into account.
Because of these gaps, SoFi has chosen to not use FICO scores when evaluating the financial wherewithal of applicants. We still consider your track record of meeting financial obligations, but we also look at a more complete picture of your financial situation than what your credit score can provide.
That means considering factors like employment history and monthly cash flow minus expenses. We’re taking a more holistic view of our applicants’ financial wellbeing – and where they’re headed – and we’re learning much more than a three-digit number would be able to tell us.”
Let’s go through SoFi’s three criteria using me as an example to see if they make sense.
1) Employment history. Check! I was employed for 13 consecutive years at a couple major investment banks until 2012. From 2012 until now I’ve been self-employed.
2) Track record of meeting financial obligations. Check! I have never missed a mortgage payment in 12 years. I have missed three credit card payments in 16 years by accident (traveling usually). All late payments were forgiven as I paid my credit card bill the moment I realized I was late, which was always within a week of the due date.
3) Monthly cash flow minus expenses. Check! I’ve been saving over 50% of my after-tax income every month for the past 16 years. In other words, my monthly gross income is triple my expenses, and my after-tax income is more than double my expenses.
Based on these three criteria, I should have qualified for a mortgage refinance in 2015. By now I would have paid at least 12 on-time monthly mortgage payments. But Chase decided my finances were not good enough, even though my monthly cash flow would have increased a further $400 if the mortgage refinance went through.
Qualifying for a loan is just one step, but the hardest step. The next step is to qualify when there’s a low enough interest rate to take. At least checking the latest mortgage interest rate or student loan interest rate can be done easily with a few clicks of a button for free. SoFi updates the latest rates right there on their page if you scroll down so you know whether the rates are worth pursuing.
TRADITIONAL BANKS NEED TO EVOLVE
The reason why traditional banks are performing poorly is because they are using archaic systems to underwrite new loans. The world has changed folks! Think about the below three situations, which are highly underserved by banks today:
1) How do you determine whether a new MBA graduate with tremendous upside potential is creditworthy if they don’t have a long credit score history?
2) Why is it that FICO is so inflexible that it cannot consider the non-US credit history of a nonresident? Is it really reasonable to view a nonresident as high credit risk just because s/he has never taken out US credit when they might have owned a home and a credit card for 10 years already?
3) Why is someone with $300,000 in freelance income less creditworthy than someone who makes $120,000 year at a day job that isn’t any more secure? Freelancers can, and often do, earn more money than those who work day jobs.
Not figuring out a way to serve the above three customer types is absurd. I’m very bullish on the way many new fintech companies are going about lending money to consumers. They’re developing new algorithms based on real-time data to make better lending decisions. Better lending decisions mean lower borrowing costs. Banks, the credit card industry, and the usurious payday loan industry need to be shaken up.
I do wonder how new fintech consumer lending companies will fare in an extended downturn since almost all of them were created after the 2008-2009 financial crisis. Lower interest rates are great for the borrower, but that also means profit margins are also much thinner. As a borrower, you want to take advantage of the current disruption and get the lowest interest rate possible!
Recommendation: If you plan to take out a mortgage through a traditional bank, you can check your Experian FICO score and credit report here. It’s still a good idea to see what your score is before finding out months into a mortgage refinance. Refinancing a mortgage in 2017 and beyond is quite stressful now due to all the rigorous requirements.
Updated for 2019 and beyond.